Breaking Into The Options Market
The Siren Song of Leverage
Options have always been a forbidden fruit for many retail customers. The siren songof leverage is often impossible for many of these customers to resist.
Unfortunately, one obstaclehas always been difficult for them to overcome -cost. The inherent leverage of options provides much more bang for thetrading dollar than any stock or index.
However, the contracts thatoffer the mostbang for the buck are frequently among the most expensive. Delta, Gammaand Vega are wonderful things,but they don't come cheap.
The Catch-22 Of The Options Market
What does the average customer do when they can't afford juicyat-the-money (ATM) options? They move their aspirations upor down the strike table until theyfind an out-of-the-money (OTM) option they can afford.
Of course, OTM optionsare cheap for a reason - they offer little value andfrequently expire worthless. Thus we come to the great catch-22 ofthe options market:
- Retail customers are lured to options by their high leverage and apparently low cost (at least when compared to the underlying). However, once they begin establishing positions, many customers are forced to use ineffective OTM options for economic reasons.
This can be particularly disheartening for customers thatare making their first tentative steps into the options market. Thepoor success rate of OTM options is often enough to drive them from the options market forever.
Binary Options To The Rescue?
One exchange is hoping to alleviate this problem with aseries of new products aimed at retail and small investors.
The AMEX isplanning to launch binary options (a.k.a. fixed return options - see "Let's Talk About Binary Derivatives" for more information on binary options) on a variety of popular equity products.
- "Retail traders tend to buy OTM, lower delta calls because they are cheaper. But then they don't get the performance that they desire," says Michael T. Bickford, Senior Vice President of Options at AMEX. "Our contracts, however, will have a full notional value of only $100. We hope the lower price of these products will help shift that retail activity down to the ATM, higher delta options that provide better performance."
To Be Continued On Tuesday In "Breaking Into The Options Market: Part Two"...
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